Tame Trading an easier way to trade

The 7 Rules of Trading Success

You might wonder why I'm using "trading success" in the title, when we are far more concerned about wealth-building success. After all, trading is just one part of our wealth-building discipline. Well, this month I thought it might be helpful to interview Jim Patterson to find out how a professional trader approaches his work.

We are, of course, using a professional trading plan in the pursuit of our wealth goals. And even though we don't actually operate Jim's Dow Double Diamond plan, and many of us don't even make the trades, it should prove instructive to learn what's important to a pro, and why. So, I'm going to give you the rules most important to professional traders, and I'm also going to add a couple that are unique to our discipline, including this first one.

Rule #1: Set a wealth goal.

Setting a goal is the first rule for trading success because you can't know which method, plan, strategy, or investment to use until you know exactly what you are trying to accomplish. Most investors just try to find "whatever investment will make the most money this month" but that's a recipe for failure (to see why, click here). Only when you have a goal -- a specific amount of money you want by a certain date — will you be in a position to know which investments are appropriate for you and which are not.

For example, if your goal is to have $1.4 million in 10 years, and you have $35,000 today, then a quick calculation will reveal you need to average 45% compound annual growth to reach your goal on time (provided you're using a tax-deferred account, such as an IRA).

Okay, once you know you need 45% compound annual growth, you can set about looking for an investing approach that can average that rate over time. You can also rule out any approach that pays less. Obviously, it will do you no good to choose a plan that can get only 25% per year, or a plan for which you cannot project the future results with any confidence. Doing so would just ensure your failure.

And thus before adopting any investing approach, you'll need to study its back-testing and live track records, to make sure it has shown that it can actually do the job you need it to do. It doesn't have to produce your desired result every year, because no plan will do that, but it must be capable of averaging your "growth rate" over several years.

Rule #2: Get a method

You must choose a well-defined system or trading method that is capable of attaining your goal. Many people just chase a hot stock. They think..."Google is going up, so I will buy it." And then later..."Holy crap, Google is down 37 points today; I'd better sell it." Where there is no method, there is no way to succeed over the long run. Sure, you might do well for a while in a rising market, but when the tide goes out, your boat will fall and maybe even sink.

The key question that every successful trader can always answer is this: Why did I do what I did when I did it?

The answer is that you're sticking to the well-defined rules of your method, a method that has shown it can deliver the compound annual growth you need to reach your wealth goal on time. Yes, sometimes when following the rules you'll get losses, maybe even a few losses in a row. But that's okay. As you'll see in a moment, losses are a necessary part of trading success.

In any case, if you can't clearly answer the above question, and also give the same answer under the same circumstances every time, then you're just guessing. Or being pulled willy nilly by the "exuberance or fear" of the day. That's dangerous. Successful traders have a method. They always know what to do and when. And they stick to their method through thick and thin.

Rule #3: Be disciplined

In an auto race, the driver of the fastest car doesn't always win. Sure, he or she might win a single race, but over the season, the experienced and disciplined driver will turn in the best record, even in a slower car. Why?

Because there are many laps to navigate, many cars to out-maneuver, plus pit stops to make and even collisions to avoid. It becomes a test of endurance...of who is not just the best driver, but the one who is the most tough-minded, disciplined, and focused on the task and goal. It's the same with trading.

Market theorist Bob Prechter says he's found "ex-Marines often make good traders because they are tough and disciplined." As a trader, you're going to have to face adversity. There will be times when your method will not be working. Are you going to throw in the towel at the first sign of difficulty? Or will you press on through good days and bad, through good months and bad, and even through good years and bad?

Have you ever noticed when you hear the story of some famous person who's "made it" that their story is always the same. They had a dream. They worked hard to obsession. They stayed focused. And in spite of near overwhelming obstacles, they never gave up until one day they achieved success.

The most successful traders believe in themselves. They believe in their method. They are tough. They are disciplined. They stay focused on their job and goal. And they never give up.

Rule #4: Get experience

Trading can look and sound easy in a book or article like this, but in actual practice, when your money is on the line, it's a lot tougher. And for that reason, there's no substitute for real-world experience. Jim recommends starting out small, learning to crawl before you walk, and especially before you run. He gave me this analogy...

Once a upon a time I was a ski instructor, and when working with the "never evers" I always started them off on flat ground. I had them put on one ski and walk around a bit, and then two skis and move around a little more. I would show them in baby steps. It was excruciatingly slow and tedious, but by the end of the day we were always going to the lift and shredding the hill on our way down. Sure, there were a few spills, but that had to be experienced, too.

And so it is with investing. You don't have to invest all your money at high leverage with a trading plan you adopted yesterday. On the contrary, start small, start slow, and gradually gain experience with your plan and the market.

Winning is great, but it's important to see how you'll hold up when you lose, and especially when you lose 4 or 5 times in a row. All professional traders experience that. Can you still follow the plan? Can you stick to the rules and make all the trades? If you want to succeed over the long haul and reach your wealth goal on time, you must learn to be tough and disciplined, and that only comes with experience.

Rule #5: Accept losses as well as gains

Making a lot of trades, piling up a lot of small gains, so that we can get a good gain for the year, and then doing that year after year is what our trading method is all about. This is our chosen path to our wealth goals. But it's important to remember that approximately half of the trades we make will be losers. And that's okay because DDD winning trades are, on average, twice the size of its losing trades. This is what I call the "money machine" aspect of our trading plan.

Just understand that you will get losses, and that those losses are part of the process. They are, in fact, a part of trading success. If you get upset, or angry, or depressed over them, then you'll never be able to make it to the finish line.

Remember, most pro baseball players fail to get a hit 70% or more of the time. Are they depressed and ready to quit because of that? On the contrary, they're thrilled they're getting on base 25% or 30% of the time. Striking out 7 out every 10 times at bat is a success. That's the game. Think how boring baseball would be if every time the players came up to bat they either hit a home run or got a base hit? Such a game would be silly and even unwatchable.

It's the same with investing. Sometimes you're going to get on base and sometimes you're going to strike out. And of course, that's what makes the whole thing work. Could there possibly be a system whereby every investor wins every time? Of course not. So, let's start by being thrilled the DDD plan has shown a 50% win rate with its winning trades twice as big as its losing trades (back-tested and live trading results since July 2002). And let's accept our losses with equanimity, knowing they are an integral part of successful trading.

Okay, that sounds good on paper...BUT...sometimes we go through a rough six months or so, when we get more losing trades than winning trades. What then? Should we throw in the towel? Not when the track record shows that this is normal and the long-term results are excellent. Remember, the only thing that really counts is this: When you add up all the winners and losers over time, do they give you the "compound annual growth rate" you need to reach your wealth goal on schedule? If so, you have no problems.

And here's something else that's important: just as you must accept your losses, you must accept your full gains. And by that I mean, don't start second guessing the plan and grabbing a quick profit, when most likely the trade has more profit in it. Every pro will tell you that once you go down that road, thinking you're smarter than your plan, you're headed for worse results. Be disciplined. A pro sticks to the rules and accepts his full losses as well as his full gains.

Rule #6: Accept responsibility

Your only job is to follow the rules, to stick to the plan, to be disciplined, focused, and determined. And to take responsibility for that. If you deviate from your discipline and things don't go well, you'll have only yourself to blame. If you get mad and blame others when things aren't going well, you're just railing against the wind.

What good does it do to blame the market, or OPEC, or some company that made an announcement that moved the market against your position? That's like a ball player blaming the rules for his failure. You can't have a successful trading plan without these things. These things are all part of the game.

The key is to accept the market. Accept market-moving events. Accept your method. Accept your wins and losses. And accept responsibility for doing your part correctly. That's how a pro approaches his trading, and if you want to succeed with a pro trading plan, you'll need to do the same.

Rule #7: Monitor your progress and make adjustments if necessary

This last rule is another one that is unique to the Dow Double Diamond approach, simply because it is not available with most other investing approaches.

Here's the drill: 1) set a wealth goal and a date for attaining it; 2) determine the growth rate needed to get your money on time; 3) make a DDD allocation plan (among the 2x, 3x, and 5x programs) to target your growth rate; 4) monitor your progress and make adjustments in your allocation plan as needed to stay on track for success.

This is a proven methodology with a proven professional trading plan. It gives you the unique benefit of choosing, today, the wealth you want tomorrow, along with a practical way to make sure you get your money on time.

The only question left to answer is, "How often should I monitor my progress?" It's obsessive and completely non-productive to fret over your results on a daily basis. Nor should you worry about them on a weekly, monthly, or even a quarterly basis. Why? Because short term results are not definitive with a pro trading plan like Dow Double Diamond, which is designed to produce good results on a yearly basis.

The problem with obsessing over short-term results is that it can lead to emotional pain. And nobody can take a lot of emotional pain for long. This is almost too obvious to state, but you can't attain your goal if you quit. So, don't put yourself in a position that could cause you to quit before you reach your goal.

The correct way to measure your progress is to do it annually. If at the end of a year, you see you're behind, adjust your allocation among the 2x, 3x, and 5x approaches to give yourself a little more annual growth for the next year. This can work out very well because the DDD history shows that quite often an under-performing year is followed by an over-performing year. Likewise, if you're ahead, adjust your allocation to give yourself a little less growth. Why would you want less growth?

Because leverage is a double-edged sword: it will increase both your profits and losses by the leverage factor. Winning isn't a problem, but for many investors losing can be emotionally difficult to handle. And for that reason it's always better to use the least leverage necessary to give you the wealth you want by the date you need it. Again, this is about not putting yourself in an uncomfortable position.

So what have we learned from the pros?

Simply this — get a method and stick to it. Be disciplined. Gain experience. Accept losses as well as gains. And accept responsibility for doing your job correctly. And to those rules we can add, "setting a wealth goal and monitoring your progress." Put all of this together and you've got a formula for success!

But what if you can't put it all together? What if you find some parts too difficult? Are you out of luck?

Of course not. Just take advantage of the auto-trading service and have all of the DDD trades made for you. Precision Futures conveniently offers 2x, 3x, and 5x trading for regular and tax-deferred IRA accounts, and it's a simple matter to allocate among these choices, and also reallocate for any necessary "growth-rate" adjustments you need to make along the way. In effect, your Precision account will automatically give you the professional advantages of following Rules #2, #3, #4, #5, and #6. Then, all you have to do is cover Rules #1 and #7. And that'll be easy!

It's not rocket science, just wealth building. Until next month...

Sincerely,

Dick Sanders